Record Health REIT Deal Enabled by Cheap HCP: Real M&A

The timing may be right for a $34 billion merger between two of the biggest managers of U.S. health-care facilities.

HCP Inc. is near its cheapest level since 2009, after it lost its title as the largest health-care real estate investment trust this year, according to data compiled by Bloomberg. The stock slump amid a slowdown in deals and the firing of Chief Executive Officer James F. Flaherty could spur Ventas Inc. or Health Care REIT Inc., known as HCN, to weigh a bid for the $17 billion company, said Adelante Capital Management LLC. A takeover by either would be the industry’s biggest deal ever.

Buying HCP could lower capital costs for future acquisitions, though it also would make it harder to find deals big enough to boost growth after that, said Stifel Financial Corp. Ventas, the biggest of the three REITs, may have more financial flexibility for a takeover than HCN, said Bahl & Gaynor Investment Counsel Inc. While no deal is imminent, investors may start encouraging HCP to explore a sale if its performance doesn’t improve after a year, said Bank of Montreal.

The valuation has “been deteriorating,” Jeung Hyun, a fund manager at Oakland, California-based Adelante Capital, which oversees about $1.8 billion including shares of HCP and Ventas, said in a phone interview. “It’s a reasonable time for the other two health-care companies to take a look at it.”

Dropped Talks

HCP had talks with Ventas about a possible deal late last year, said a person familiar with the matter. The deal fell apart after Flaherty left the CEO job, said the person, who asked not to be identified because the discussions were private.

Lauralee Martin took over for Flaherty, who was fired because HCP’s board lost confidence in his “leadership and his leadership style,” the nursing-home owner said Oct. 3.

Representatives for Long Beach, California-based HCP didn’t respond to requests for comment. Lori Wittman of Chicago-based Ventas and Zachary Ottenstein of Toledo, Ohio-based HCN said their companies don’t comment on market speculation.

Shares of most health-care REITs have fallen in the last 12 months on prospects for higher interest rates. While HCN dropped 12 percent and Ventas slipped 16 percent, HCP plunged 24 percent.

Deal Dearth

The laggard performance by HCP is tied to investor uncertainty about the company’s direction after the abrupt management change and a dearth of dealmaking, said Michael Carroll, an analyst at Royal Bank of Canada. HCP hasn’t spent a dollar on acquisitions since buying 133 senior housing communities for $1.7 billion in October 2012, according to data based on reported deals compiled by Bloomberg.

Martin is still somewhat of an unknown for shareholders, who are waiting to see how she will make her mark on HCP, said Rich Anderson, a New York-based analyst at BMO.

If about a year goes by without any meaningful deals or internal improvements that lift the stock, investors may “start asking the question, ‘Why don’t you sell yourself?’” Anderson said in a phone interview. “As big as these companies get, nothing surprises us in terms of what the next step could be, and I can’t say I’d be terribly surprised if one of these humongous companies got twice as big.”

HCP last week was valued at 14.84 times its earnings before interest, taxes, depreciation and amortization, not far from its lowest valuation since July 2009, according to data compiled by Bloomberg. The company also has the cheapest price-earnings multiple among 11 U.S. health-care REITs valued at more than $1 billion, the data show.

Good Timing

“This probably is a more likely time than normal for a merger to happen,” John Leslie, a money manager and analyst at Miller/Howard Investments Inc., said in a phone interview. While he said a deal may never materialize, if HCN or Ventas have any interest in HCP, “now is probably the time” to strike.

Miller/Howard, based in Woodstock, New York, oversees about $6.7 billion, including shares of HCP, HCN and Ventas, according to Leslie.

Should HCN or Ventas merge with HCP, the combined company would be valued at about $34 billion, based on yesterday’s closing stock prices. HCN’s market capitalization is $17 billion and Ventas’s is closer to $18 billion, data compiled by Bloomberg show.

HCP stock fell 0.2 percent to $37.12 today. HCN dropped 0.6 percent to $58.08, and Ventas declined 1.1 percent to $59.38.

The largest health-care REIT deal on record was Ventas’s acquisition of Nationwide Health Properties Inc. for about $7 billion, according to data compiled by Bloomberg.

‘Very Large’

“They’re all very large so a merger between any two of the three would create a very, very large REIT,” Stephanie Thomas, a fund manager at Cincinnati-based Bahl & Gaynor, which oversees about $11 billion including shares of HCP, HCN and Ventas, said in a phone interview.

Ventas’s debt is 0.53 times its market capitalization, compared with HCN’s ratio of 0.63, data compiled by Bloomberg show. That may give Ventas more financial flexibility than HCN, Thomas said.

The appeal of a merger with HCP for either would be the opportunity to reduce capital costs, said Rob Mains, a Saratoga Springs, New York-based analyst at Stifel.

A transaction would also create barriers to finding potential future deals, which are needed to fuel earnings growth, he added.

“It’s been tough for all three of the big health-care REITs to do a lot of M&A over the last year or so,” the analyst said. “If they were to double in size, then they would have to do double the amount of acquisitions to sustain the same percentage growth.”

Strategic Fit

HCN also may not be interested in a deal because it has been working to reduce its exposure to skilled nursing facilities, said Carroll of RBC. Buying HCP would move it in the opposite direction, he said. Any deal would also have to gain regulatory approval and pass antitrust tests.

Even though HCN and Ventas have been more acquisitive than HCP, they still face pressure to do deals. That’s particularly true because they probably missed out on senior-housing operator Emeritus Corp., which agreed to sell itself to Brookdale Senior Living Inc. last month, said Hyun of Adelante Capital.

“This was one of the first times where a big deal kind of got away from the REITs, so I think there’s additional pressure on the REITs to do something bigger, to show that they can still acquire, they can still use their currency to do accretive transactions,” Hyun said.

While doubling in size may make it harder to find meaningful deals later, “you dance until the music stops,” he said. “As long as it’s accretive and as long as the companies are getting rewarded for growth, I think they have to do it.”

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